- noun a risk that someone will behave immorally because insurance, the law or some other agency protects them against loss that the immoral behaviour might otherwise cause
- noun the possibility that a party to a contract will do something to his or her own benefit which will harm other parties, and so obtain benefits promised under the contract. An example would be that a property owner might want to burn down the property to get the insurance money.
- (written as Moral Hazard)
This is of two main types. Ex ante moral hazard refers to the effect that being insured has on behaviour, generally increasing the probability of the event insured against occurring. Ex post moral hazard derives from the price- elasticity of demand: being insured reduces the patient's price of care and hence leads to an increase in demand by insured persons. The basic economics of ex post moral hazard can be elucidated by considering the diagram. The vertical axis shows the price of health care P (assumed - implausibly in health care but expositionally convenient - to be set equal to marginal cost) and the marginal value placed upon health care consumption by an individual. The horizontal axis indicates the rate of consumption of health care (so much per week, month, etc.). The demand curve, or marginal value curve is not perfectly inelastic, indicating that at lower prices more care (longer in-patient stays, for example) are demanded (up to a limit). The horizontal line is the (constant) marginal cost curve. In a world of no insurance, the individual faces a price 0 P at which 0 C 1 care will be consumed when ill. Let the individual (while healthy) consider buying insurance. Suppose neither the individual nor the insurer is in any doubt about the probability, p, of illness striking in any period (another tall order). Given that the insured, when uninsured, would consume P 0 C 1 the actuarially fair premium (sometimes termed 'risk premium') is p times the cost of this amount of care. We assume (again for simplicity) also that there is zero loading - that is, the insurer adds nothing to the premium to cover the administrative costs of operating the insurance serve. Now let the event insured against occur. Assuming that the premium payment has not had an effect on the individual's income sufficient to shift the demand curve, the amount demanded will now be 0 C 2 - being insured reduces the price of consuming care to zero. Expenditure by the insurer will be 0 PdC 2 - much larger than the amount upon which the premium was based. This is ex post moral hazard. It is held to be inefficient because the cost of producing C 1 C 2 care is much more than its value to the consumer - there is an excess burden or deadweight loss, or 'waste' of adC2. However, before rushing to the conclusion that moral hazard must be controlled through coinsurance, copayments and other forms of rationing, it needs to be borne in mind that there may be reasons for wanting individuals to consume more care than, given their personal circumstances, they would normally choose (see, for example, externality). If such grounds exist, then a second best optimum may entail the need to do less to constrain demand (and even to encourage it further.). Even more fundamentally, there may be reasons for entirely eschewing the idea that the demand curve reveals anything worth knowing about the value placed on health care. In that case, even if the behavioural account given of moral hazard may still stand, the ethical accusation of 'waste' entirely fails.
One behavioural effect of moral hazard in a market-based system is evidently to cause premiums to rise - in the example just considered, the increase in the premium is p (C 1 adC 2). Premiums thus reflect both the inherent element of risk (the fair premium) and the additional costs generated through moral hazard. This may be sufficient not only to cause the insured to withdraw from insurance and self-insure, it may, as in the figure, actually exceed the cost of purchasing out-of-pocket the original planned consumption of care at price P. The welfare effects of moral hazard ought thus to be considered both in terms of its impact on health care utilization and on the take-up of health care insurance.
Another form of moral hazard has been held to be the effect that be ing insured in public programmes like the US Medicaid has on savings. Thus, because Medicaid will pay for, say, the nursing home care of the elderly with few savings, then the poor have an even smaller incentive to save than they do being poor. As with other forms of moral hazard, one needs to ask again whether the consequence is intended or unintended, desirable or undesirable. Rice (1992) argues against using the demand curve as a reliable indicator of a person's welfare.